Reality Checks on Europe and China

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Reality hit the market open today – two realities, actually -- something that normally does not happen.

Europe: The European Community bailout of Ireland is in place – and creates a permanent mechanism for resolving issues such as these in the future. This should make traders happy; it did not. Why?

  • The creation of a permanent mechanism means the crisis is ongoing and political leaders and bankers do not believe the bear bonds are going to stop with Ireland. They are headed towards Portugal and Spain as we speak.
  • As with Ireland, the issue with Spain is larger than sovereign debt – it is private sector debt, property debt that shrinks in value every day as the collapsed property bubble buries more and more banks. The Irish guaranteed their banks, creating the need for a bailout of the government. What will Spain do? Bond bears and traders think the country will eventually need a bailout.
  • The Germans did what they wanted, sort of – after 2013, holders of bonds issued in that year and afterward take a haircut if there is trouble and a “restructuring is needed.”
  • Those new to the trade are reading data about European problems and thinking, "These guys are dead,” increasing negative sentiment.

Bottom line: the euro is going down, based on political and economic instability and the eventual need to print more euros, regardless of what the Germans are uttering right now. And this will push the dollar -- and, once profit-taking is over, gold and silver -- up.

On to China and its "fifty-first state," North Korea.

China is showing it is unreliable, at best, as a regional leader and totally unprepared or unwilling to step up to any responsibility as a world leader. It refuses to blame North Korea for the killings last week, refuses to acknowledge its own role in letting the crazies in Pyongyang get the bomb – and that in turn led to Pakistan going nuclear and is helping Iran to go in that direction. This role of the Koreans is spelled out clearly in the Wikileaks documents unveiled this weekend. What does this have to do with the market?

  • It is increasingly clear that China has been waging “asymmetric warfare” against the U.S. because of America’s presence in eastern Asia. This strategy is outlined in a book entitled Chao Xian Zhan, which translates as Unrestricted Warfare. Written by Chinese colonels Qiao Liang and Wang Xiangsui, the book shows how to engage the United States without directly engaging the U.S. Computer attacks from “unknown” hackers; economic warfare with currency manipulation and so on; and, of course, tying up American resources using surrogates such as North Korea. This reality is now sinking in and adding fuel to trade tensions between governments.
  • China is clearly manipulating its currency, steals intellectual property more than any nation on earth, uses state banks to subsidize targeted industries, and forces foreign companies into partnerships or rips them off if they get too successful. This has made business less than supportive of “fair trade” policies in recent months.
  • China is a primitive power, similar to a mid-nineteenth century nation-state driven by near hysterical nationalism. One day after a clash at sea between Japan and China, the Chinese cut off rare earth exports to Japan. This, and other ham-handed behavior, has made east Asian nations less supportive of a "go slow and easy" approach with China.
  • North Korean moves of late have been well beyond the norm even for that mad nation-state. The Chinese control the flow of oil, food and other goods into Korea -- and can stop it at any time, as North Korean generals are paid via the skimming of profits from the resale of goods coming in from China (the money being kept offshore). Several years ago, the North Koreans came to the bargaining table when these accounts were tracked down and frozen. Bottom line: No one believes the Chinese are “afraid” of turmoil in North Korea from people starving; instead, they are afraid the generals will get angry because their money has been cut off and will do something stupid. This makes everyone less supportive of China and makes it even more imperative that the Chinese take the lead in resolving the problem -- which they are refusing to do.

Who benefits from this crisis? Eventually, gold, silver and the dollar -- outposts for the scared and nervous.

Who loses? The Chinese. They have been exposed as a one-trick paper tiger – they want money to flow in, while the world gets nothing in return. And the backlash has begun. Even though South Korea and the U.S. tentatively said yes to multi-party talks with North Korea, the Japanese, remembering the cut-off of rare earth shipments and perhaps tired of this constant instability, said no.

Also look for China to resume rare earth shipments and sign some agreement not to do it again as a price for Japan coming into the multi-party talks. This will drive down the price of rare earths and that in turn would make some rare earth companies – and the rare earth ETF, REMX -- short candidates.